Every business requires capital to grow. Capital is the fuel on which businesses run. One of the reasons for failure of a start-up is that they run out of cash early in their life-cycle. Funding helps accelerate the pace of growth, in marketing & expansion of business and in getting the right resources on board at the right time. Founders’ ability to execute, potential market of the business, future cash requirements, and business plan play a very important role in funding.
(Also read this blog on how one can improve a business' cash flows)
Businesses usually raise funds or capital from external sources once they have exhausted own capital. There are multiple options to raise money – bootstrapping, crowdfunding, debt, equity, & in some cases, funding from governments.
Let’s start with bootstrapping. Though bootstrapping is not entirely an external source of capital, it means building a business with own funds and those of family & friends. The cash generated from business is used for funding everyday operations of the firm.
With no external investors on board, the entrepreneur retains complete control over the firm, its strategy & operations. Bootstrapping allows entrepreneurs the freedom to experiment with new products/strategies. Bootstrapping puts the onus on cashflows and cost control that enhances the chances of short-term profitability.
While the entrepreneur enjoys freedom of operation & reaps the rewards, he also bears all the risks associated with the business, having invested his capital in the business. Limited resources in the firm can inhibit the growth, prevent promotion and affect the quality of the product. Lack of credibility is one of the downsides of being a bootstrapped business. Backing of a reputed investor/investor can enhance the visibility of the business.
Spanx, GoPro, Craigslist, GitHub and Tough Mudder are some of the well-known global companies which made it big while being bootstrapped.
When compared with various traditional funding options, crowdfunding is not a mainstream approach. Crowdfunding means raising funds from a large number of individuals through various crowdfunding websites such as Kickstarter, Ketto etc.. In India, rules regarding crowdfunding are regulated by SEBI (Securities and Exchange Board of India).
One of the main downsides of crowdfunding through platforms such as Kickstarter is that they do not collect money until a fundraising goal is reached, so a lot of time is wasted and can delay the growth of business. There are also chances of underestimating the funds required to be raised. The upside though is that businesses can pitch their business plans to a large audience with ease.
Crowdfunding has lower risks, provides with larger investment pool and parting with equity is optional. There is however a risk of the idea itself being stolen, lower flexibility in product development with high pressure for quick results.
Having a small network of friends and family who will fund the business, giving them perks for the investment made, presenting an effective business plan will help in ensuring a successful crowdfunding campaign.
Wishberry, Ketto, Indiegogo, Kickstarter, Impact Guru, Milaap are some of the crowdfunding platforms.
Seed or angel funding is the first external investment in a business which is typically followed by venture capital investment. Angel or seed investors participate in businesses that are in an early-stage and have few or no customers at all. The investors are usually group of individuals who invest their capital in such early-stage businesses, seed funds that invest in such ventures or individual investors. Earlier the stage of business, higher is the risk of investment.
Seed or angel investors typically invest in the range of $ 10,000 to $ 150,000 and in some cases, the investment can be as high as $ 1 million. Y Combinator, a global seed fund, for example, usually invests around $ 120,000 for a 5-10% ownership in businesses accepted into its accelerator program.
Angel Investors invest in business in the form of equity instruments – plain vanilla equity shares or a convertible note which converts into equity shares at a future date based on some outcome. Convertible notes are preferred instruments when it is very difficult to put a value to the business due to various factors.
Blume Ventures, Chennai Angels, Indian Angel Network, Hyderabad Angels, GSF, Kae Capital, Y Combinator, Mumbai Angels are some of the well-known seed or angel investors in India.
Once a business is in its growth trajectory and a larger amount of capital is required for expansion, businesses resort to raising capital from professional, institutional investors. This is where venture capital (VC) and private equity (PE) investors come into picture.
Both VC and PE firms take money from outside investors and invest them into companies in the hopes of a return down the line. They’re structured almost identically, with Limited Partners (LP) providing the money (these can be private individuals, companies, pension funds, etc.) and General Partners (GP) managing it. Both have teams looking for potential investments, vetting them, doing due diligence, and actually approving and inking the deals, but who does what, how, and what happens after the deal is closed is wildly different.
Venture Capital is a type of private equity, investing in firms that have long-term growth potential. These businesses usually have a successful revenue model in place or a growing customer base with a set revenue strategy. They typically invest in the range of $ 1 mn to $ 20 mn across investment rounds. VC’s have the power to influence major decisions of the business. VC firms are usually run by a mix of entrepreneurs, Investment bankers or finance professionals.
A Venture Capital firm typically uses investment instruments such as common equity shares, preferred shares and convertible debt to make their investments. Convertible securities are investments that can be converted to equity at a later point in time.
Sequoia Capital, IDG Ventures India, Tiger Global, Naspers, Matrix Partners are some of the venture capital firms with interest in investing in Indian businesses.
The key difference between a VC and PE investment is the stage at which the investment is made into the business. While a VC firm bets on a business quite early in its evolution, a PE investor looks into a business once the business has garnered significant scale and, in the path, to becoming a large business which could be taken public (IPO). Private Equity investors typically invest in companies that have gone beyond generating revenue and have profitable margins, stable cash flow, and are able to service a significant amount of debt. PE firms are favored by companies because it gives them access to liquidity and is an alternative to banks or listing in public markets. PE firms invest much larger sums in a single business - anywhere from $ 10 mn to $ 250 mn or even $ 500 mn in some cases.
Kotak Private Equity Group, Ascent Capital, Motilal Oswal Private Equity, KKR, Everstone, Peepul Capital, The Carlyle Group, The Blackstone Group, TPG Capital, Warburg Pincus are some of the leading Private Equity firms with interest in India.
No matter what the stage of business or the quantum of capital needed, there is an investor suited to invest in the business. Each investor comes with their set of pros and cons and it is the advisor here to the promoters or founders who assists in decoding a lot of these complex pros and cons and make decision making easy for the business.
Baywiser assists businesses across the capital raising cycle – right from preparing & vetting business plans (financial model, information memorandum etc.), advising on capital structures, connecting to investors & handling the entire process, drafting term sheets and definitive agreements, assistance in due diligence, right till closure and beyond.
The author can also be reached at firstname.lastname@example.org